Stock splits & dividends

If a company thinks its stock price is too high or too low, it can consider a stock split. There are two types of stock splits: forward and reverse.

• Forward stock splits increase the number of shares outstanding.
• Reverse stock splits decrease the number of shares outstanding.

Forward stock splits

Forward stock splits are used when a company believes its stock price is too expensive for the average investor. Suppose ABC Company’s stock price has risen to $500 per share, which is relatively high (many stocks trade between $30-$150). ABC Company could lower its price per share through a forward stock split.

A forward split increases the number of shares you own, while the price per share decreases proportionately. The total value of your position stays the same. Let’s work through an example.

A stockholder owns 100 shares of ABC Company at a current market price of $500 per share. How will a 4:1 forward stock split impact shareholders?

Each stockholder receives four shares for every one share owned.

To find the stock split factor, divide the first number by the second number

$\text{SS factor}=\frac{\text{first SS number}}{\text{second SS number}}$

$\text{SS factor}=\frac{\text{4}}{\text{1}}$

$\text{SS factor}=4$

To find the number of shares adjustment, multiply the original number of shares by the stock split factor

$\text{New shares}=\text{old shares x SS factor}$

$\text{New shares}=\text{100 x 4}$

$\text{New shares}=\text{400}$

To find the price per share adjustment, divide the original price per share by the stock split factor

$\text{New price}=\frac{\text{old price}}{\text{SS factor}}$

$\text{New price}=\frac{\text{\$500}}{\text{4}}$

$\text{New price}=\$125$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $500 = $50,000

$\text{After the split:}$

• 400 shares @ $125 = $50,000

To build confidence with stock split calculations, here’s a real-world example: Apple’s 7:1 stock split in 2014.

Now try one on your own.

A stockholder owns 300 shares at a current market price of $90 per share. The issuer performs a 3:2 stock split. What adjustment is made to the investor’s position?

What is the stock factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

In each example, the stockholder ends with the same overall value ($27,000 in the last example). What changes is:

• the number of shares owned
• the market price per share

A simple analogy is slicing a pie. If you cut one pie into two slices, you now have two pieces instead of one - but you don’t have more total pie.

Sidenote

Even vs. uneven stock splits

Stock splits can be described as even or uneven based on the split ratio.

An even stock split ends in the number “1.” Here are some examples of even stock splits:

• 2:1 stock split
• 4:1 stock split
• 7:1 stock split

If a stock split ends in any number other than 1, it’s considered uneven. Here are some examples of uneven stock splits:

• 3:2 stock split
• 5:4 stock split
• 7:2 stock split

Reverse stock splits

Reverse stock splits are used when a company believes its stock price is too low (the opposite of a forward split). Instead of waiting for market demand to push the price up, a company can use a reverse stock split to increase the price per share immediately.

Let’s go through an example.

An investor owns 100 shares of stock at a current market price of $10. How will a 1:5 reverse stock split impact the position?

Each stockholder receives one share for every five shares owned.

To find the stock split factor, divide the first number by the second number

$\text{SS factor}=\frac{\text{first SS number}}{\text{second SS number}}$

$\text{SS factor}=\frac{\text{1}}{\text{5}}$

$\text{SS factor}=0.2$

To find the number of shares adjustment, multiply the original number of shares by the stock split factor

$\text{New shares}=\text{old shares x SS factor}$

$\text{New shares}=\text{100 x 0.2}$

$\text{New shares}=\text{20}$

To find the price per share adjustment, divide the original price per share by the stock split factor

$\text{New price}=\frac{\text{old price}}{\text{SS factor}}$

$\text{New price}=\frac{\text{\$10}}{\text{0.2}}$

$\text{New price}=\$50$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $10 = $1,000

$\text{After the split:}$

• 20 shares @ $50 = $1,000

Before you work through an example on your own, here’s a real-world example: Citigroup’s reverse stock split in 2011.

Try one on your own now.

A stockholder owns 400 shares at a current market price of $20 per share. The issuer performs a 4:5 reverse stock split. What will the investor’s stock position become?

What is the stock factor?

How many shares will the stockholder end up with?

What is the new price per share?

Summarize the final result.

As in the forward split examples, the stockholder ends with the same overall value ($8,000 in the last example) after the split.

Stock splits (forward and reverse) affect all stockholders, so proportionate ownership doesn’t change. If an investor owns 25% of the outstanding shares before a stock split, they’ll still own 25% after the split.

The pie analogy works here too. If you and three friends each own 25% of a pie, slicing your piece into smaller pieces doesn’t change your ownership of the whole pie - you still own 25%.

To summarize, stock splits don’t change overall investment value. They do change:

• the price per share
• the number of shares outstanding

Although stock splits are relatively insignificant in the long run, they require approval* from stockholders.

*Stock splits (forward and reverse) affect a common stock’s par value. While par value on common stock is a relatively unimportant accounting measure, actions impacting par value generally require shareholder approval.

Stock dividends

Stock dividends are another way to receive additional shares. Like stock splits, stock dividends are a reshuffling of numbers that can influence the stock price.

If a company pays a 25% stock dividend, each investor ends up with 25% more shares, and each share falls proportionately in price. The overall value of the position stays the same.

If you understand the math behind stock splits, stock dividend math will feel very similar. Here’s an example.

An investor owns 100 shares of stock at $20/share. The investor receives a 25% stock dividend. What changes?

Let’s go through the math. First, find the stock dividend factor.

To find the stock dividend factor, add the stock dividend percent (in decimal form) to 1

$\text{SD factor}=\text{SD (decimal form) + 1}$

$\text{SD factor}=\text{0.25 + 1}$

$\text{SD factor}=\text{1.25}$

To find the number of shares adjustment, multiply the original number of shares by the stock dividend factor

$\text{New shares}=\text{old shares x SD factor}$

$\text{New shares}=\text{100 x 1.25}$

$\text{New shares}=\text{125}$

To find the price per share adjustment, divide the original price per share by the stock dividend factor

$\text{New price}=\frac{\text{old price}}{\text{SD factor}}$

$\text{New price}=\frac{\text{\$20}}{\text{1.25}}$

$\text{New price}=\$16$

Put it all together and compare before and after to confirm

$\text{Before the split:}$

• 100 shares @ $20 = $2,000

$\text{After the split:}$

• 125 shares @ $16 = $2,000

As you can see, the investor ends with the same overall value ($2,000). Comparing “before” and “after” is a good way to confirm your calculations.

Now try one on your own.

An investor owns 300 shares of JPM stock @ $115. They receive a 15% stock dividend. What changes?

In conclusion, stock splits and stock dividends change the number of outstanding shares but don’t cause shareholders to gain or lose overall value. Both can move the price per share up or down, but there are differences.

The most important difference to remember is voting:

• Stock splits require shareholder approval.
• Stock dividends do not (similar to cash dividends).

With Board of Directors approval, a stock dividend can occur whether stockholders want it or not.

Key points

Forward stock splits result in:

• More shares outstanding
• Lower price per share
• Same overall value

Reverse stock splits result in:

• Fewer shares outstanding
• Higher price per share
• Same overall value

Stock dividend consequences

• More shares outstanding
• Lower price per share
• Same overall value

Stockholder approval (voting)

• Stock splits require approval
• Stock dividends do not require approval